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Corporate Legal

Security agreement — Legal glossary

Marjorie Richter J.D.  

· 5 minute read

Marjorie Richter J.D.  

· 5 minute read

Where to start when drafting a security agreement. Includes definition, key concepts, best practices for drafting, and the agreement's structure

Legal glossary · securities law · security agreement

The Black’s Law Dictionary 1909 definition of “security agreement” is “[a]n agreement that creates or provides for an interest in specified real or personal property to guarantee the performance of an obligation.” In a security agreement, the borrower (also called “debtor” or “grantor”) pledges property as collateral that the lender (also called “creditor” or “secured party”) can sell to satisfy the debt if the borrower defaults.

The advantage of this arrangement to the lender is that it avoids the problems that come with defaults on unsecured loans – having to sue the borrower, enforce the judgment via the sheriff, and be last in line if the borrower declares bankruptcy.

Today, the Uniform Commercial Code (UCC) Section 9, entitled “Secured Transactions,” governs security agreements. All states have adopted Section 9 and its revisions, though some have modified the wording or added to it. You should consult the version of the UCC from the state whose law governs the agreement.

UCC Section 9 applies to personal property. Real property, with the exception of fixtures, is outside of its scope (UCC § 9-109(d)(11)). For transactions involving an interest in or lien on real property, consult the applicable state real property laws.

The Black’s Law definition also states that a security agreement “must provide for a security interest, describe the collateral, and be signed by the debtor. The agreement may include other important covenants and warranties.” All of these remain important considerations for drafting a security agreement today.

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Key concepts for drafting a security agreement


Drafting best practices


How to structure a security agreement


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Key concepts for drafting a security agreement

Attachment — The security interest must “attach” to the collateral to be enforceable (UCC § 9-203). To attach:

  1. The lender must provide value to the borrower.
  2. The borrower must have rights in the collateral.
  3. The borrower must authenticate a security agreement, usually by signing it either on paper or electronically (unless certain other conditions apply).

Perfection — determines which lender will have priority when multiple lenders have security interests in the same collateral. The most common method of perfection is to file a UCC-1 financing statement with the Secretary of State or other designated state office. With a few exceptions, the first lender to file will have priority over subsequent filers.

Drafting best practices

Granting language — You must include language in the security agreement that grants a security interest, but you’re not required to use any specific language. Security agreements typically use the terms “grant,” or “pledge,” or both. You should avoid using the term “assign” because it may be ambiguous.

Description of collateral — The description of the collateral must be “sufficient,” meaning that it reasonably identifies what it is describing. A very general description, such as “all the borrower’s assets,” will not be sufficient (UCC § 9-108). Security agreements usually use the UCC’s categories of collateral.

Borrower’s name — Must be correct and sufficient in the filing statement for the interest to be perfected (UCC § 9-503).

Filing the financing statement — Generally, the financing statement must be filed in the state where the borrower is located, which is determined according to the rules in UCC § 9-307.

Choice of lawThe borrower’s location, not the parties’ choice, also generally determines which state law governs perfection and priority (UCC § 9-301). However, for other matters in the security agreement, use the choice-of-law rules that apply to contracts in general in UCC § 1-301.

Long-form agreements — A long-form agreement, like the one outlined below, is generally more appropriate for large deals than for smaller ones.

How to structure a security agreement

A typical long-form security agreement contains multiple key sections.

Preamble

In the preamble, indicate the document is a security agreement, and state the date and parties to the agreement.

Recitals

The recital section is optional but recommended. Use it to describe the structure of the agreement.

Definitions

Definitions may be negotiated or taken from the UCC. They are typically the same as the definitions used in the underlying loan agreement.

Grant of security interest

This is the key section of the agreement. It contains the granting statement and descriptions of the pledged collateral.

Representations, warranties, and covenants

Representations and warranties contain information necessary for perfection. Covenants may prohibit or require the borrower to take specified actions in order to protect the value of the collateral.

Remedies

Both UCC § 9-601 and the terms negotiated in this section of the agreement provide for the lender’s rights if the borrower defaults.

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